40% of Family Wealth – Gone!
The Federal Reserve Board issued a report Monday stating that the typical American family lost a lot of wealth in the Great Recession. Specifically, the median decline was 40% from 2007 to 2010. The Fed study shows that it hurt middle-aged folks (aged 35 to 44) the most with a 54% decline in family net worth. The headline, in print and online, definitely fell under the heading of gloom.
The reasons for the decline are not hard to fathom. Housing prices and the decline in the stock market hurt people in all age groups. Stock prices, as measured by the S&P500, dropped 32.7% from May 2007 to June 2010 (the peak and trough). Existing home prices dropped 23.7% from mid-2007 through December 2010.
The good news is that the stock market has rebounded 27.1% since the June 2010 trough. Existing home prices have yet to recover, but new home prices are up 8.5% since the trough. The picture is obviously not as gloomy as the headlines would have us believe. The Fed reports that net worth rebounded in the first quarter of 2012 by the largest amount in seven years.
Two things come to mind based on the above. One is that an investment in real estate will be a good way to recoup family net wealth to pre-recession levels. Buy a single-family home and rent it out and you will enjoy positive cash flow from the first month if you put enough cash into the deal. You will also use other people’s money to amortize the debt and thus create some wealth even if prices do not rebound significantly. Second, any price increase in the future (and there will be some) also adds to the family wealth. Real estate provides three ways to enhance the wealth picture. You may be thinking that you don’t want to deal with tenants. Neither do I. Use a property management firm. It will cut into profits, but you will sleep better.
The second thing that comes to mind is that your age is important. A 60-year old does not have much potential to regain the family wealth. A 40-year old has many more years of real estate price rise potential and stock market rise, both of which will rehabilitate the family fortune to well beyond the median pre-recession level of $126,400.
Let’s assume the purchase of a $158,100 home (the median price today) of a single-family rental property that delivers $2,000 a year in free cash. We will ignore potential rent increases in the future. We will also assume a 25% ($39,525) down payment and a 15-year mortgage. The $2,000 in free cash will be invested for 15 years with an average 4% annual return on investment.
The single investment of $39,525 will yield the following:
1. $183,433 home – Original $158,100 property (now paid off) after 15 years of 1% annual assumed residential inflation.
2. $ 40,047 – Future value of a $2,000 annual annuity invested at an average annual return of 4% for 15 years.
The real estate investment provides for a family wealth increase of $223,480, or $97,080 higher than the pre-recession level.
In case you were wondering, investing the $39,525 deposit at 4% compounded quarterly for the next 15 years, and the $2,000 annual investment at 4% per year for 15 years, renders a family wealth of $111,851. This is below the pre-recession level and $111,629 below the real estate option. Leverage the real estate and get ready for the future.
Hate charts, hate economics – until today. Brian made me a believer.